What Are Custodial Fees?
Custodial Fees and Safekeeping Fees in the Modern Investing World
One of the things you are likely to encounter at some point in your lifetime, especially if you are fortunate enough to become affluent or high net worth, are custodial fees, sometimes referred to as safekeeping fees. These terms can mean different things depending upon the context of your specific investment portfolio but I want to walk you through the definition of custodial fees, explain when and where you are likely to see them, and give you an idea of what may be considered reasonable so you have a general idea of whether or not you're getting a fair shake.
The Definition of Custodial Fees and Safekeeping Fees
These days, custodial fees can refer to one of a handful of fees charged you by a qualified financial custodian such as a bank trust department or registered broker dealer.
Custodial Fees - When you invest in stock, pick up a corporate bond or tax-free municipal bond, purchase shares of a mutual fund, or otherwise become an owner of a security, the executing broker has to take cash out of an account and use it to pay the person or institution from whom you are making the acquisitions. When it receives the security, it has to put it somewhere for you. Unless they are requesting a physical stock certificate, which is rare these days, or insisting upon use of the direct registration system held through something like a direct stock purchase plan, successful investors often have it placed in a global custody account of some sort. (To learn more about that topic, read my article How Does Global Custody Work? Understanding Global Custody Accounts and Fees.) The custodian keeps the assets safe, collects your dividend and interest income for you, gives you a monthly or quarterly account statement, handles any corporate actions such as receiving shares of a spin-off or making an election for cash or stock based upon your instructions following a merger, and a host of other housekeeping tasks that would become overwhelming and quickly out of date if most investors had to deal with them personally.
Safekeeping Fees - This term has become rarer in the past couple of decades but it usually, though not always, refers to a service, particularly by bank trust departments, for handling custody on behalf of a client who wants to keep his or her physical stock certificates on hand at the bank, in his or her name rather than a street name.
The bank trust department or custodian would deal with things like physically handing over the stock certificate to the broker prior to the settlement date in the event the investor had placed a sell order or adding additional certificates received from spin-offs to the vault, making sure the investor received his or her entitled share. When a security or asset in placed in safekeeping, the investor or depositor is given a receipt proving ownership. The asset does not become the property of the institution, it is merely holding on to it, so even if the institution went bankrupt, its creditors couldn't go after it and it would have to be returned to the rightful owner.
How Much Do Custodial Fees and Safekeeping Fees Cost?
The tricky part about custodial fees and safekeeping fees is they can't always be compared on an apples-to-apples basis. Between being a private investor for most of my career, the Investing for Beginners Expert since 2001, and the Managing Director of a soon-to-launch global asset management business, I've seen more fee disclosures than most investors will in a lifetime (sometimes, I can be a bit to candid in my assessment of how different business models are structured).
Everybody is different and you get different things from different institutions at different costs.
For many investors, the most common place to hold assets in custody is with their broker in a brokerage account; a convenient option that is so seamless that many people don't even realize they are different functions. Unless special treatment is requested, these securities will almost always be held in a street name, meaning technically, on the books of the corporation in which you hold equity ownership through stocks or lend money through bonds, the investor doesn't exist. Rather, those assets are owned by the brokerage firm, which then internally records your beneficial interest in its own accounting records. Many brokerage firms now default to having customers open margin accounts rather than cash accounts, which has troubling implications when you understand the potential rehypothecation disaster as certain firms are rumored to be arbitraging regulatory differences between the United States and the United Kingdom.
Brokerage firms do this to attract as many investors as they can in the hopes of generating trading commission revenue. As a result, many firms waive custody fees entirely so you don't even realize you're paying them (they're effectively baked into the commissions on trade executions). It isn't unusual for some firms to charge minimum fees, such as $100 per year, if you don't have a certain amount of money in your account or you don't engage in any trades for a certain length of time to help it offset the expense of servicing the account. These aren't always a ripoff and, in fact, can be fair. At the time I write this, look at an institutional-like trading platform such as Interactive Brokers. If a customer of the firm has less than $100,000 in an account, and generates less than $10 in trading commissions per month, a makeup fee of the differential is applied so that each account pays at least $120 per year, which covers Interactive Brokers' costs, including custody costs. This is necessary because Interactive Brokers focuses on large, significantly wealthier clients who want economies of scale. Customers are allowed to choose between a fixed rate fee schedule and a tiered fee schedule. On the tiered schedule, by way of illustration, the commission is $0.0035 per share for U.S. stocks with a maximum commission rate of 0.5% of the trade value. That means if you bought 1,000 shares of The Hershey Company as of June 3rd, 2016, at $93.49 per share for a total of $93,490, you'd pay Interactive Brokers a commission of $3.50, or 0.0037%, plus some nominal exchange fees, clearing fees, and other fees which are equally as microscopic. It's quite literally a rounding error. You either have to be a sufficiently large account or generate some trading revenue for it to justify keeping your assets in custody without charging you. Interactive Brokers isn't being unfair, it's entirely reasonable.
If you go the route Benjamin Graham recommended in his treatise, The Intelligent Investor, and hold your securities in custody with a bank trust department - fully paid, in cash, with no chance of an institutional collapse coming near the assets you have the institution hold for you - you should probably pay only a handful of basis points per annum for the service assuming your account is more than six-figures. One of my favorite regional banks in the country assesses a custodial fee of only $50 per annum. Another I saw a long time ago charged $25 per position up to a maximum of $250 for individual investors.
Keep in mind, though, that if you are using a third-party custodian who is not affiliated with the executing broker, the executing broker may charge special fees. This is one of those cases where a scenario would help. Imagine you run a asset management group. You use Charles Schwab as the recommended custodian for most of your private clients. One day, for whatever reason, you execute a trade through a different prime broker, such as Pershing, buying a significant block of Coca-Cola which you want to allocate among your client custody accounts at Schwab. Since you didn't use Schwab to execute the trade, your clients will pay Pershing their share of the trade execution commissions but then Schwab is going to charge each custody account a $25 "trade-away fee", as it is known. There can be a lot of legitimate reasons to engage in trade-away transactions that work in the overall favor of a client and Schwab isn't going to provide its custody services for free if it can't make money off the trades, so it's a case of everybody behaving fairly and reasonably. Schwab is not doing anything wrong or overcharging the custody client.
Special Types of Accounts May Charge Justifiably Higher Custodial Fees
When dealing with non-standard assets such as a hedge fund investment held in the form of limited liability company membership units or limited partnership units, specialty custodians who agree to deal with these securities often charge higher fees, which can vary from institution to institution. The same goes for a rarer type of self-directed Roth IRA, self-directed IRA, or other self-directed retirement plan that can make sense for rich investors who want to do something like buy an entire apartment building in the confines of their tax shelter so they pay no tax on the rental income provided they follow a host of strict rules, such as not using borrowed money of any kind and not using or being involved in the property themselves. These custodial fees can run into the thousands of dollars per year but can be worth it, without question, for the right type of investor under the right circumstances as it would be otherwise impossible for him or her to take advantage of the sort of unique portfolio strategy that produces so much passive income. This is not an area in which the inexperienced should treat lightly.
How to Think About Custodial Fees in the Broader Context of Your Portfolio
Custodial fees and safekeeping fees are one of the things that make up your personal expense ratio, along with other fees such as registered investment advisor fees, personal financial planner fees, the "look-through" fees on exchange traded funds, index funds, and mutual funds, and whatever other costs you incur in the management and administration of your investment portfolio. Unless you're dealing with specialty products and services, I'd get nervous if all-inclusive costs on portfolios larger than $1,000,000 was higher than 1.50%, inclusive of custody fees and all other expenses and presuming some sort of international equity exposure. That focus - all-inclusive costs - is important. I've seen situations in which the fee calculations are structured in a way where a firm charging 1.50% is effectively assessing lower fees due to the way certain cash and asset classes are treated than a firm purporting to charge only 0.75%. You cannot pay attention to the sticker rate in isolation, you must understand the effective assessed fee on your portfolio.
One caveat I'd offer is the existence of certain firms that cater to the high net worth. In some rarer cases, you might see someone paying 2.5% expenses on a $10,000,000 portfolio or something, which sounds bizarre. Look closer because there is probably something else going on that makes sense in context as those are not really covering only asset management costs. The rich engaged in these arrangements frequently know what they are doing and the value they are getting. After all, you don't become wealthy, and stay wealthy, by being bad with money in most cases. The people opting for this sort of fee level aren't concerned with under-performance relative to the S&P 500 or the Dow Jones Industrial Average, they're almost always getting something else as part of a basket of services that they think provides them more net utility; private banking, tax planning, estate tax structuring, access to certain products or services, insurance audits and asset protection mechanisms including trust funds, or any number of other things that aren't applicable to a significant majority of American households. If you're 75 years old and sitting on an eight-figure or nine-figure net worth, getting money into the hands of your children and grandchildren quietly, efficiently, and in ways that protect them from losing everything if they make a mistake can keep your family's collective net worth significantly higher than the first-glance, elementary evaluation of the relative savings compared to a low-cost index fund.
Even those who aren't super rich sometimes benefit from these seemingly-high fee arrangements in the right context, which won't apply to everyone. For example, imagine you are a successful farmer who, through a lifetime of hard work and diligence, has built a $10,000,000 portfolio of blue chip stocks and investment grade bonds. You were a do-it-yourself investor for most of that time. Your husband or wife, whom you love with all of your heart and is a great person, is five years younger than you and statistically likely to outlive you by fifteen or twenty years. For all his or her good traits, he or she is horrendous with money; unable to balance even a checkbook. In such a case, it can make a lot of sense to couple a certain type of trust fund, which puts the assets in trust and allow the spouse to live off the income without touching the principal, which will be inherited by your children, grandchildren, charities, or other heirs and beneficiaries following the spouse's death, and then pay a corporate trustee to handle all of his or her bill paying and expense management for life. After you're gone, your husband or wife will never have to think about paying the phone bill, medical bills, tax bills; all taken care of without them having to even see a statement, every cash flow meticulously documented should they ever wish to inspect it. To focus on what may appear to be significantly higher costs and fees is to make the mistake our ancestors did when they looked at classical economic models rather than behavioral economic models. In other words, yeah, you'll pay a lot more and underperform the benchmark in most cases but what good is paying only 0.05% compared to 2.50% if in the former scenario, all of your money ends up in the hands of a casino, bill collectors, or a second spouse and his or her children and grandchildren following your death? I, and many of you, have watched this sort of thing unfold and it is entirely unnecessary. Remaining ignorant of its possibility for the sake of attempting to cut fees is the embodiment of "penny wise, pound foolish".